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Predictability in international asset returns : a re-examination

Neely, Christopher J. and Weller, Paul A.
(1999)
Predictability in international asset returns : a re-examination.
Working Paper.
University of Warwick: Warwick Business School Financial Econometrics Research Centre.
Working Papers Series, Vol.1999
(No.3).

Abstract

This paper argues that inferring long-horizon asset-return predictability from theproperties of vector autoregressive (VAR) models on relatively short spans of data is potentiallyunreliable. We illustrate the problems that can arise by re-examining the findings of Bekaert andHodrick (1992), who detected evidence of in-sample predictability in international equity andforeign exchange markets using VAR methodology for a variety of countries over the period1981-1989. The VAR predictions are significantly biased in most out-of-sample forecasts andare conclusively outperformed by a simple benchmark model at horizons of up to six months.This remains true even after corrections for small sample bias and the introduction of Bayesianparameter restrictions. A Monte Carlo analysis indicates that the data are unlikely to have beengenerated by a stable VAR. This conclusion is supported by an examination of structural breakstatistics. Implied long-horizon statistics calculated from the VAR parameter estimates areshown to be very unreliable.